---
sidebar_position: 4
---

# LP Risk Minimisation ☔️

The maximum possible loss an LP could incur in a prePO position is **known in advance**, **completely transparent**, and **presented to the LP** on a confirmation screen before they open a position.

Additionally, prePO's unique architecture is designed to **heavily minimise** the max loss LPs could incur in a position.

This is a significant advantage compared to most other AMMs, where **risks are unclear** and LPs are often liable to lose **significant percentages** of their position due to factors like [impermanent loss](https://finematics.com/impermanent-loss-explained/).

<center>
  <figure height="50%">
    <img alt="Max Loss displayed in a prePO Transaction Summary" src={"/img/max-loss.png"} />
    <figcaption>Max Loss displayed in a prePO Transaction Summary</figcaption>
  </figure>
</center>

## Risk Minimisation Mechanics

### Payout Ranges

Long and Short tokens in prePO markets trade within the bounds of a [Payout Range](/concepts/markets#payout-range), which sets a price floor for each token.

Setting a lower bound on the possible price of Long and Short tokens allows Pregens to control the maximum [impermanent loss](https://finematics.com/impermanent-loss-explained/) an LP could incur in a position.

If there was no Payout Range, LPs would be liable to lose 100% of their position in the scenario that a token trended towards $0.

Of course, there are tradeoffs to consider when choosing a token price floor. Learn more about the tradeoffs on the [Parameter Tradeoffs](/developer/parameter-tradeoffs) page.

### Natural Hedging

When an LP provides liquidity to a prePO market, two AMM positions are opened under the hood. 50% of the deposit is added to the $L/preCT$ AMM and 50% to the $S/preCT$ AMM, using a [Zap-like](https://learn.zapper.fi/articles/what-is-a-zap) mechanism.

Each AMM position is subject to its own Position Profit or Loss ($PPL$) which is influenced by a combination of factors, including [impermanent loss](https://finematics.com/impermanent-loss-explained/) and market exposure to pool assets.

Let's define

- $PPL_S$: The $S/preCT$ position $PPL$
- $PPL_L$: The $L/preCT$ position $PPL$
- $PPL_{net}$: $PPL_S + PPL_L$

Given the $S/preCT$ pool provides Short exposure and the $L/preCT$ pool provides Long exposure, $PPL_S$ and $PPL_L$ are inversely correlated, giving the LP position the properties of a natural hedge.

### Variable Market Exposure

Even though LP deposits are divided equally between the $L/preCT$ and $S/preCT$ pools, the Long and Short exposure provided by each pool is not equal.

This difference gives a Long or Short to every LP position, further minimising the maximum loss the LP could incur.

Let's explore where this exposure comes from, and how it minimises LP maximum loss.

As an asset is purchased from a concentrated liquidity pool, the Real Reserves of the asset decrease until the price ceiling is reached, at which point the Real Reserves will be completely exhausted.

<figure>
  <center>
    <img alt="Real Reserves" src={"/img/real-reserves.png"} style={{ maxWidth: "20rem" }} />
    <figcaption><span>Real Reserves Curve</span><br/><sub>Source: <a href="https://uniswap.org/whitepaper-v3.pdf">Uniswap V3 Core</a></sub></figcaption>
  </center>
</figure>

Applying this in the context of prePO:

- When an LP deposits into a market when the price of $L$ is $<0.5$, they get more Long exposure from their $L/preCT$ position than they get Short exposure from their $S/preCT$ position
- When an LP deposits into a market when the price of $L$ is $>0.5$, they get more Short exposure from their $S/preCT$ position than they get Long exposure from their $L/preCT$ position

The resulting Long or Short exposure offsets losses in the scenario where the most volatile price swings occur.

Let's consider an LP opening a position in a market with a Valuation Range of $20B - $80B and current valuation of $25B. 

- The $L/preCT$ component of the LP position consists almost entirely of $L$ tokens
- The $S/preCT$ component of the LP position consists almost entirely of $preCT$ tokens

This LP position has Long exposure, which minimises their maximum loss.

- If the $L$ price increases, the gains from their $L/preCT$ position will outweigh losses due to impermanent loss and the $S/preCT$ position
- If the $L$ price decreases, the losses LP could realise from the $L/preCT$ position are minimal, due to the $L$ price already being close to the floor at the time of deposit

### 3 Layers of Rewards

LP losses are offset by [3 Layers of Rewards](/concepts/rewards).
